ECB to stay the course

Comments by Franck Dixmier, Global CIO Fixed Income at AllianzGI, ahead of the ECB meeting on 27 October, 2022 

With euro zone inflation settling at high levels, the European Central Bank should hike rates in line with expectations at its next meeting. Markets will also focus on what Christine Lagarde may have to say about shrinking the central bank’s balance sheet.

• We expect a 75bp rate hike at the next European Central Bank meeting on 27 October.
• Inflation is settling in at high levels, and the ECB, which is behind the curve, is not expected to deviate from its hawkish rhetoric and its willingness to act quickly and strongly.
• This 75bp increase is well anticipated by the markets.

Since the last European Central Bank (ECB) meeting in September, little has changed in the context of inflation. Inflation continues to rise, with a 1.2% price increase compared to August, although September's figure of +9.9% year-on-year[1] is slightly below market expectations of 10%. Inflation is settling at high levels and spreading to the economy, as indicated by its core part, at +4.80% year-on-year. However, wage negotiations have only just begun in a tense social climate throughout the euro zone.

On the other hand, the ECB's situation is becoming more uncomfortable, with headwinds making its task more difficult. Compliance with its mandate requires it to raise rates as much as necessary to bring inflation to a path compatible with its price stability objective. But the policy mix in the euro zone is hardly helping: government support plans for purchasing power and demand are encouraging price increases. Moreover, growth is weakening week after week, pointing to an imminent entry into recession, although it is difficult at this stage to gauge the extent of the slowdown. The latest activity indicators in the euro zone confirm the deceleration and contraction of activity. The Purchasing Managers' Index (PMI) for the manufacturing industry fell from 49.6 in August to 48.4 in September[2], signalling a further deterioration in economic conditions, with the contraction reaching its highest rate since June 2020. Meanwhile, the services PMI fell to 48.8 in September from 49.8 in August.

However, the ECB's assessment should remain unchanged: behind the curve, it must continue to act fast and hard and is expected to announce a 75 basis points (bp) rate hike. This figure is widely anticipated by the markets and should not come as a surprise.

It will be interesting to hear from ECB President Christine Lagarde about reducing the central bank’s balance sheet. Indeed, the governors' meeting should allow them the opportunity to start discussing Quantitative Tightening (QT). Christine Lagarde is expected to reaffirm that QT will only start after the end of the rate hike cycle without giving details on the timing. This approach is not consensual, as Bundersbank President Joachim Nagel has already expressed his desire to reduce the balance sheet as soon as possible. Markets will be watching with interest 

  [1] Source: Eurostat, September 2022

[2] Source: S&P Global Eurozone Manufacturing PMI, September 2022

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[1] Source: Eurostat, September 2022

[2] Source: S&P Global Eurozone Manufacturing PMI, September 2022